Bank Distress Means More Deals Are Ahead

Rest assured, lenders will look to reduce exposure to troubled real estate, observes Pat Jackson of Sabal Investment Holdings.

Pat Jackson

To the dismay of many, interest rates remain elevated as the Fed holds course to combat inflation. While no cuts have occurred to date in 2024, many business leaders believe the first in a series may occur in June. However, it also seems likely that cuts will happen as quarter percentage points over time, which will keep rates high well into next year.

Of course, the stress of interest rates to banks is well known. Banks, in particular the small and regional institutions, are the largest providers of commercial real estate loans. Today, many are still holding a high volume of these loans on their balance sheets during this period when property values have declined significantly, and borrowers are struggling to keep payments on their loans, many of which are floating rate, currently. Higher profile large loan defaults involving reputable real estate players are starting to hit the news.

In early November, I wrote on Commercial Property Executive about anticipated asset dispositions banks would engage in to move commercial real estate loans off their balance sheets, citing three core transaction types that would provide investors distress opportunities while simultaneously helping banks recover. So, with the obvious stress in the banking and commercial real estate sectors and no movement to interest rates, why haven’t we seen more of these transactions? Save for a few high-profile examples (the FDIC-led sale of the $16.8 billion Signature Bank asset portfolio to a Blackstone-led venture is one of these), we haven’t yet seen banks bringing large nonperforming loan portfolios to market.

It begs the question, will investors in distress ever see the opportunities they are will for come to market?

I still posit that all three transaction types—including FDIC-structured transactions, privately negotiated bank transactions, and single-asset deals—are likely to emerge in greater number. Since I last addressed this in November, most deals in the market have been single-asset dispositions and bulk loan portfolios have been few and far between. But these single distressed loan asset sales fail to address the magnitude of the problem and, at some point in the near future, banks are going to have to make larger, bolder moves to right the ship.

Inevitable outcomes

The exposure to commercial real estate on bank balance sheets is still in the trillions. To assume this incredible mass of CRE loans coming due won’t impact banks, especially community and regional organizations, is simply naïve. Some banks with the earning power to do so are building reserves up into a war chest to help alleviate future write-downs or further erosion of values. Others who don’t see a way to get ahead of the issue are starting to think about alternative solutions like mergers or capital raises. And yes, banks are starting to become more comfortable with the idea of, and are even exploring, large loan portfolio sales to investors with the capacity, experience and ability to work them out via a longer-term strategy.

To be clear, banks looking at loan asset sales are not weak and shouldn’t be viewed as such. Because of the nature of what they are, banks are ill-suited, even prevented, to own real estate. A financial institution in this position seeking to offload non-performing loan assets is one whose leadership understands it has done all it can to help the borrower and his/her loan perform. The obvious next step is to turn said asset(s) over to a buyer who is not constrained by the same regulations a bank is and that can execute via longer-term strategy, pursuing alternate remedies such as foreclosure.

I’ve said many times in the past that while these loan asset sales may not be fun for banks to endure, they are a necessary occurrence in the market, especially at a time like this. They allow everyone—whether borrower, bank or industry at-large—to ultimately move past this unfortunate and persistent bump in the road.

While there still may be some room for valuations to decline a bit further, longer hold investors are now comfortable transacting and taking on these problematic assets. Because even if values decline further, these longer-term investors will still come out ok in the end. With banks starting to accept that the sale of non-performing assets is the only imminent option and investors now ok with pricing, we should expect to see more of these assets trading hands in bulk through this year and next.

Pat Jackson is founder and chief investment officer of Sabal Investment Holdings, the real estate investment management firm serving institutional investors.

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